IRS Gives Employers Break on Misclassified Employees

The Internal Revenue Service is offering a break to employers who come clean about wrongly classifying workers as independent contractors to avoid paying federal payroll taxes, the agency announced this week.

What happens when workers are considered independent contractors?

Employers don’t have to pay various taxes, including unemployment insurance taxes, workers’ compensation premiums or the employer’s share of Social Security and Medicare taxes. Workers also may have fewer rights, including overtime protections.

Employers accepted into a new IRS program must reclassify workers as employees and cough up a bit more than 1 percent of the wages paid to the workers for the past year. The IRS says no interest or penalties will be due, and employers will not be audited on payroll taxes related to these workers for earlier years.

The program covers only federal taxes; employers could still be liable for unpaid state taxes.

To qualify, employers must have classified the workers as independent contractors in the past and filed all of the associated tax forms. Employers who have simply been paying workers under the table need not apply, IRS Commissioner Doug Shulman said. Businesses already being audited are also ineligible.

The agency, Shulman said, is trying to encourage “the right behavior so that people pay their taxes this year, five years from now and 20 years from now. We want to make it as easy as possible for people to come in and get right going forward.”

The IRS did not set a deadline to apply. Shulman said the agency will monitor the program.

If businesses don’t come forward and are later caught wrongly classifying employees as independent contractors, they could be liable for three years’ worth of employment taxes, plus interest and penalties.

“For a small business, it obviously takes a worry off their back and gets them right, which most small businesses, I think. want to be,” Shulman said. “For us, it’s getting people in compliance for the long run.”

Shulman acknowledged the law is confusing about when businesses should classify workers as employees or independent contractors. The IRS, however, is prevented by a 1970s law from issuing guidance to clarify the rules, Shulman said.

In determining whether a worker is an employee or a contractor, employers must weigh the degree of control they have over the worker, the IRS says on its website.

“Does the company control or have the right to control what the worker does and how the worker does his or her job?” the IRS asks. “Are there written contracts or employee type benefits?”

Shulman said the agency does not have a good estimate on how widespread worker misclassification is. A report by the Government Accountability Office estimated that in 1984, 15 percent of employers were wrongly classifying workers as independent contractors. The way many businesses operate has changed significantly since then

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